Delaying your state pension could work wonders for your retirement income –
and you don't have to work any longer

Thousands of people may be able to double the income produced by their private pensions by exploiting the new savings freedoms to boost the value of their state pension.

Only those approaching retirement may be able to use this little-known wrinkle, created by changes to the pension rules announced in the Budget in March. The ploy will be of particular interest to savers with modest funds which they intend to convert into an income.

On a typical £40,000 pension pot, pensioners can currently obtain £1,400 a year through an inflation-linked annuity. This money could instead be used to secure an inflation-linked £2,800 a year from the state.

So what is the secret? The key is to delay the date at which you take your state pension. For each year of delay, the Government raises the pension's value by 10.4pc, in addition to annual increases linked to inflation.

Until the Budget, delaying your state pension was viable only if you continued to work beyond retirement age, or had savings on which to live in the interim.

But under the liberalisations announced by George Osborne three months ago, people will from next April have complete flexibility over how they access their pensions. As a result, experts said there was an opportunity to delay taking the state pension and use the funds from a private or company scheme to cover day-to-day living instead.

When these pension funds run out, you simply lock into this larger state pension, which is guaranteed by the Government and should increase each year with inflation.

Not everyone will be able to take advantage, though. The quirk in the rules benefits only those who will reach their retirement age before April 2016, when the new single-tier state pension is introduced. This restricts the ploy to men currently aged 63 or over or to women who are at least 61.

Under the new single-tier pension, those reaching retirement age from 2016 will receive around £155 a week. Yet as part of the reforms the annual uplift for delaying the payout will be cut in half.

Alan Higham, retirement director at investment firm Fidelity, said it was savers of more ordinary means, rather than the super-wealthy, who would benefit most from running down their pension funds early.

"Those with relatively modest pensions often can't afford to take significant risks with their money, whether it's investing in the stock market or gambling on how long they will live," he said.

"For this reason many of these savers will still be looking for a guaranteed income when they retire. Most people will assume that the only way of delivering this is buying an annuity. But if they chose to spend the money from their pension instead of taking their state pension, they should end up with a higher income without taking any more risk."

Here is an example of how the scheme might work. Imagine a 65-year-old man who retires with £40,000 in his pension fund. He is entitled to a state pension (basic state pension plus state second pension) of, let's say, £7,000 a year. If he decides to buy an inflation-linked annuity with his pension savings this would give him £1,400 a year – so a total of £8,400.

If he chose to defer his state pension and withdraw £9,800 from the pension fund, leaving the balance in cash, he would have a higher overall income – which he can effectively guarantee for life.

If each year he increases the amount withdrawn by 5pc to cover rising living costs, the fund would run out in around four years, by which time his income would have risen to £11,910. At this point he could take his deferred state pension, which would also have grown to £11,910, assuming it had been uprated by 10.4pc a year in line with the rules on deferral and by an extra 5pc a year for inflation. This means there is no decrease in his income. Had he taken his state pension and the annuity from the start, his income would have reached just £10,210 by this stage – £1,700 less. In both cases, the pension would then continue to rise in line with inflation.

There is no guarantee that the Government will keep its promise to uprate the state pension with inflation. Currently it has a "triple lock" whereby pensions increase by inflation, earnings or 2.5pc (whichever is highest). But this is not guaranteed beyond the next election. While the rules might be modified, it would be highly contentious to scrap indexation retrospectively.

State pension delay: your step-by-step guide

First, check that delaying your state pension and running down other savings is suitable for you. Inheritance and death benefits will be sacrificed, and those with large pensions can probably generate better returns elsewhere.

Billy Burrows of advisers Key Retirement Solutions said: "The trade-off is losing flexibility. The pension reforms have gifted an array of opportunities to savers and it seems counterintuitive to give these up. Getting financial advice when you retire has never been more worthwhile." Those with medical conditions should check the income on "enhanced" annuities.

But if you are sure the state pension deferral route is right for you, move your pension into a low-cost "drawdown" plan that allows you to keep the money in cash and make regular withdrawals. For example, Fidelity charges £750 for this service, with advice on this ploy included. Advisers can determine a safe level for withdrawals and ensure the plan remains on course so that the state pension starts at the point the funds run dry, and adequately replaces the income.